EC330-3-SP – Lecture 5
Transition Strategies: Big Bang vs Gradualism
Alexander Mihailov
University of Essex
Plan of talk
• Introduction
1. Initial conditions before transition started
2. Transition: definition, objectives, constraints,
strategies
3. Stylised facts about key country experiences
4. Gradualism vs big bang: a model on the trade-offs
• Wrap-up
A. Mihailov, U of Essex, EC330-3-SP – Lecture 5
2
Aim and learning outcomes
• aim: understand
– how transition can be defined and analysed
– what the trade-offs are in opting for a transition strategy (big bang vs
gradualism)
• learning outcomes
– discuss the legacy of central planning in the light of differing or similar
initial conditions of transition paths
– describe the objectives and constraints of transition and the debates and
policies that have been implemented
– analyse and compare the outcomes of these debates and policies, as they
were reflected in the reforms launched in, and the data gathered for, the
transition economies
– provide a theoretical perspective on the stylised facts of transition
A. Mihailov, U of Essex, EC330-3-SP – Lecture 5
3
Initial conditions of the (classical)
socialist economy: a general summary
• no markets: the price system (completely) absent
• plan instead: allocation of goods by the planning administration
• no autonomous enterprises: told what to produce, from whom
to buy and to whom to sell
• hence, distorted structure(s)
– bias to (heavy) industry (overdeveloped) vs services (“unproductive”,
Marx) – Roland, T.1.1, p. 6
– bias to large vs small firms – Roland, T.1.2, p. 7
– bias in output mix and quality originating in an incentive structure that
maximises plan indicators (and, hence, costs…)
• inefficiency in real behaviour: Nove (1958), glass planned in tons (too thick
and heavy), then in square metres (too thin and fragile)
• inefficiency in financial behaviour: Kornai (1980), soft budget constraints
A. Mihailov, U of Essex, EC330-3-SP – Lecture 5
4
Initial conditions in real-world
socialist economies: (certain) diversity
• Central Europe
–
–
–
–
GDR: a “success story” of orthodoxy
Hungary: 1956, gradual changes since 1968
Poland: 1979-1980 crisis (martial law), 1989 shock therapy
Czechoslovakia: 1968, “normalisation”, velvet revolution
• Eastern Europe
– Yugoslavia: “market socialism” since 1965
– Albania, Bulgaria, Romania: essentially, no much reform
– Estonia, Latvia, Lithuania: 1939 in USSR, 1991 out of USSR
• USSR
• non-European (formerly) socialist economies
– Ex-Comecon members: Cuba, Mongolia, Vietnam
– Recipients of assistance from USSR: North Korea, Laos
– China: the dual-track system since 1979
A. Mihailov, U of Essex, EC330-3-SP – Lecture 5
5
No guidance from theory
(nor from previous experience)
• unpreparedness of the economics profession
– early literature was largely verbal, aimed at giving advice
– but Western advisers were only equipped with theories of
macroeconomic stabilisation and with some experience with reforms in
developing countries
• whereas transition should be understood as a multi-dimensional
process of a large-scale institutional change of “marketising”
centrally planned economies
a major challenge was that complementary reforms had to take place
without creating too much economic disturbances, as the economy must
continue to function: as if “changing the engines of a plane while it keeps
flying” (Roland, 2000)
A. Mihailov, U of Essex, EC330-3-SP – Lecture 5
6
An economic system
• is characterised by 5 building blocks (Kornai, 1992, 1998)
–
–
–
–
–
political system
dominant ownership structure
dominant mode of economic coordination
incentives
market situations
• therefore its sustainability as well as transformation cannot be
separated from the political sphere:
“economic interests as shaped by incentive structures and allocative
mechanisms translate, through the political system, into political
coalitions that sustain existing arrangements or lead to their
transformation” (Roland, 2000)
A. Mihailov, U of Essex, EC330-3-SP – Lecture 5
7
The strategic vision:
from plan to market (– but how?…)
• what was expected
– stabilisation programmes would restore external and internal
macroeconomic balance
– at the same time bringing about a mild recession of a short duration, i.e.
1-2 years = transformational recession (Kornai)
– to be followed by bottoming out
• what generally happened did not meet the above expectations
– output fell more than anticipated and the supply response was greatly
delayed, even in the most favourable cases
– structural changes lagged everywhere
– many other “surprises” could be further enumerated
• our understanding of transition remains limited and happens
mostly “after the fact”…
A. Mihailov, U of Essex, EC330-3-SP – Lecture 5
8
The choices involved
• on the speed of transition: shock therapy vs gradualism
– shock therapy = big bang = cold turkey = a simultaneous
and quick implementation of all (transition) reforms
– gradualism = sequencing of (transition) reforms in a given
(hopefully “optimal”) order
in the case of gradualism, also on the particular sequencing of
reforms = the order in which measures in stabilisation (-cumtransformation) packages should be implemented
• comparative overview by country and reform: Roland
(2000), Table 1.3, p.15
A. Mihailov, U of Essex, EC330-3-SP – Lecture 5
9
Transition as a large-scale
institutional change: objectives
• improving allocative efficiency by correcting the distortions of
socialism through
– introduction of flexible prices
– and creation of competitive market environment
• stabilising the macroeconomy, which is necessary for a correct
functioning of the price system
• providing better incentives and corporate governance
arrangements to make firms respond to market signals
– privatisation at a large scale
– encouragement of entry of new private firms and creation of an
entrepreneurial class
• creating government institutions “adequate” to markets
– need for political and institutional stability
– need to protect private property rights from encroachment (by the
government but also by the mafia)
A. Mihailov, U of Essex, EC330-3-SP – Lecture 5
10
Transition as a large-scale
institutional change: constraints
• uncertainty of outcomes, at both aggregate and individual levels
– because the model of capitalism toward which transition economies should
converge is not necessarily clear (role of government in the economy)
– because even if the goal of transition is clear, there is no accepted theory of
how to get there (experimentation and learning during transition)
• complementarities and interactions between reforms
e.g. privatisation and price liberalisation
• political constraints
– crucial, especially in Eastern Europe (vs China) where political reform – the
move to democracy – preceded economic reform – the move to the market
– transition is an economy-wide process involving winners and losers, even if
aggregate welfare is (expected to be) ultimately enhanced
A. Mihailov, U of Essex, EC330-3-SP – Lecture 5
11
Did the USSR/CPSU (in)voluntarily
left the socialist system to break up?
• the socialist economic system rested upon the monopoly of the
communist party => a breach in this monopoly triggered its
collapse under Gorbachev
– the legitimacy of CPSU was allowed to be questioned in USSR
– CPSU renounced support of that legitimacy in the “brother countries”
• in early 1989, CPSU
– did not condemn the “round table” negotiations in Poland
– did not block the progress toward multipartism in Hungary
• in the autumn of 1989 “the winds of change” swept through
Eastern Europe and the Berlin Wall was down in a night
• 1991, collapse of CMEA (Comecon) => trade at world prices
(but arrears in TRs initially created settlement problems)
A. Mihailov, U of Essex, EC330-3-SP – Lecture 5
12
GDR: a unique experience
of an immediate monetary union
• key dates
– 9 November 1989: breach of the Berlin Wall
– 1 July 1990: economic and currency union
– 3 October 1990: political union – GDR became the five new provinces
(Neue Länder) of reunified Germany
– 1989-1994: privatisation tackled by the Treuhandanstalt
• lessons from GDR’s unique “merger”: even with favourable
conditions, the pain from transition was largely underestimated
– financial burden was huge: the Western part of the country devoted many
more funds (and effort) to this task than the assistance made available to
the remaining countries in transition
– material losses were huge: a large share of the productive capacities were
dismantled as obsolete or harmful to the environment
– human costs were huge as well: GDR population had one of the highest
• participation rates (80% in 1989) under socialism
• unemployment rates (10% in 1991) among the ex-socialist countries
A. Mihailov, U of Essex, EC330-3-SP – Lecture 5
13
Poland and Russia:
diverse big bang experiences
• Poland: shock therapy
– July 1989: G-7 Summit empowers the Commission of the European
Communities with the coordination of assistance to Poland and Hungary
=> PHARE (in 1990, Czechoslovakia, Bulgaria, Yugoslavia and, later,
Romania added to PHARE)
– catastrophic situation, default on foreign debt
– January 1990: Leszek Balzerowicz (advised by Jeffrey Sachs) launched
what became known as “shock therapy”
– 1991-1995: mass privatisation blocked politically => privatisation
proceeded de facto in a gradual way
• Russia: “a shock without the therapy” (Ellman, 1992)
– various successive programmes announced and partly launched in 19921993 were based on a shock therapy concept (if only to please IMF)
– but were altered due to political conflicts of all sorts and not implemented
A. Mihailov, U of Essex, EC330-3-SP – Lecture 5
14
China: gradualism
under the dual track approach
•
•
a plan track: production and prices are frozen at a defined pre-existing level,
usually last period’s output
a parallel market track: liberalisation is carried out at the margin so that
market transactions can take place outside the plan track
– since 1979 in agriculture: contract responsibility system
• the commune was assigned the responsibility to sell a fixed quantity of
output to the state procurement agency and to pay a fixed amount of taxes
• it had the right to receive a fixed quantity of inputs, e.g. chemical fertilisers
• the commune was otherwise free to do whatever it wished
• it reassigned the collective responsibilities to the individual farm households
and made them directly responsible for the fulfilment of their shares
– since 1984 in industry
•
• within-quota output according to the plan
• parallel free markets for the above-quota output of enterprises
designed to be Pareto-improving (Roland, 2000): the Chinese dual-track
system both
– provides the efficiency gains from price liberalisation
– and protects individual agents from welfare losses
A. Mihailov, U of Essex, EC330-3-SP – Lecture 5
15
Dewatripont and Roland (1995, AER):
model assumptions
• uncertainty is aggregate, in the sense that
– the outcome of transition, as a whole, is not clear
– agents involved are ignorant of the underlying process: as if
“without a map”, Shleifer and Treisman (2000) book title
• two reforms
– if implemented simultaneously = big bang
– if implemented sequentially, after uncertainty resolution on
the first reform = gradualism
– complementarities between the two reforms
A. Mihailov, U of Essex, EC330-3-SP – Lecture 5
16
Dewatripont and Roland (1995, AER):
model conclusions
• the type of uncertainty and learning during the reform process
matter in the comparison of the two strategies
– gradualism has an option that a big bang does not have, namely the
option of early reversal at a lower cost
– because gradualism has this additional option of early reversal after
partial uncertainty resolution, it may take reforms easier to start
• for gradualism to be optimal
– the first reform has to be informative (i.e. learning is possible from
experience with its implementation)
– furthermore, learning needs to be fast enough
• otherwise, big bang cannot be dominated
A. Mihailov, U of Essex, EC330-3-SP – Lecture 5
17
Concluding wrap-up
• what have we learnt?
–
–
–
–
what transition is
how initial conditions were related to strategies chosen
in what aspects the actual transition strategies differed
which the trade-offs b/n gradualism and shock therapy are
• where we go next: to the theoretical analysis of
macroeconomic stabilisation
A. Mihailov, U of Essex, EC330-3-SP – Lecture 5
18